The year ahead will likely remain sharply challenging for Asian hedge fund managers looking to raise new investor capital. But the “stars” of recent years that have lodged standout gains will continue to see moderate inflows from their traditional investors – US institutions – while new entrants are turning to ultra-high net worth investors, family offices and their own friends amid a dearth of institutional seed capital.

Aidan Houlihan, Managing Director for BNY Mellon’s Alternative Investment Services in Asia discusses the outlook for 2013. “From my vantage point here in Hong Kong, I believe the gathering trend for 2013 is the continued gradual evolution of Asia’s hedge fund community. Although we expect fewer fund launches over the next 12 months, we do anticipate that the new crop will be more diverse in its range of investment strategies. This will support Asia’s gradual shifting away from a monolithic emphasis on equity long-short strategies. Already,more esoteric credit and macro-oriented strategies as well as multi-strategy funds have entered the market. Today, equity long-short funds account for roughly 75 per cent of hedge fund assets under management, down from 90 per cent just a few years ago. “

Houlihan continues: “We believe the hedge fund industry in Asia will continue to grow and evolve and provide investors with more options. Whilst it is certainly true that we expect to see fewer launches in 2013, we believe the quality of the funds coming to market and level of assets under management they will raise on launch date will continue to increase. In my opinion, one of the main headwinds for the average hedge fund in Asia in the year ahead will continue to be raising capital. The new capital coming into Asia will largely be limited to outliers that have significantly outperformed both peers and the broader market. These fund managers have consistently been rewarded with capital inflows, and investor interest in them remains high.”

The Asian hedge fund industry posted strong gains to conclude 2012, led by hedge funds investing in China, India and Japan, as capital invested in the Asian hedge fund industry increased by 7.5 per cent for 2012, according to the latest HFR Asian Hedge Fund Industry Report. Total hedge fund capital invested in the Asian hedge fund industry increased to USD88.25 billion, the highest level since 2007, prior to the Financial Crisis. Total capital increased by USD3.9 billion in 4Q12 on a net new inflow of USD1.17 billion concentrated in Emerging Asia. Total capital invested in the hedge fund industry globally increased to a record level of USD2.25 trillion as of year-end 2012.

The HFRX China Index posted a gain of +8.0 per cent for the last quarter of 2012 and +9.4 per cent for the full year, in line with the fourth quarter gain for the Shanghai Composite but outperforming Chinese equities for the full year as economic growth and inflationary pressure slowed into year end. The volatile HFRX India Index gained +4.3 per cent for 4Q12 and +27.6 for 2012, topping the gain of the Mumbai Sensex 30 and leading all regional hedge fund indices for 2012. Japanese elections and the ensuing economic policy stimulus resulted in strong year end gains for the Nikkei 225 and a sharp decline in the Japanese Yen, which traded at a 27-month low against the US dollar. The HFRX Japan Index gained +2.5 per cent in 4Q12 and +8.1 per cent for 2012, trailing the strong year end gain for Japanese equities. The HFRX Korea Index posted a narrow decline of -0.25 per cent in 4Q12, in line with the Kospi Index.

The total number of Asian hedge funds increased by +5.3 per cent in 2012 to nearly 1,150 with almost a third (31.7%) of all Asian hedge funds are located in China, an increase from 28.6 per cent as of year-end 2011. The per centage of Asian hedge funds located in Japan and India also increased in the past year, while the per centage of funds located in Singapore and Australia, which represent the 2nd and 3rd largest share of Asian-domiciled fund locations, declined in 2012.

“The Asian hedge fund industry was well positioned for the series of important Asian macroeconomic developments which occurred in the 4Q, including moderating growth throughout Emerging Asia, the Japanese elections and the dramatic impact of the BoJ stimulus plan and inflation target increase on Japanese currency and equity markets,” stated Kenneth J. Heinz, President of HFR. “Asian investors continue to exhibit preference for tactical exposure to powerful trends in Japanese currency and equity market trends with a bias toward continued weakening of the Japanese Yen. As this dynamic environment continues to evolve, Asian-focused Equity Hedge and trend-following, quantitative Macro Systematic CTA strategies are likely to capture and benefit from these powerful trends.”

In an interview with a regional publication, Stefan Nilsson, CEO and founder of HFC Advisory Group that the Japan-related hedge fund industry is a relatively large part of the overall Asian hedge fund industry. "In addition to the locally based hedge fund managers in Japan, there are many Japanese hedge funds managed from Singapore and Hong Kong and some run from London and the US" Nilsson said.

Locally, the hedge fund industry in Japan has two parts to it: one part consists of locally managed hedge funds, which Nilsson says, are mostly relatively small with just a few multi-billion dollar fund managers. "The more significant part consists of local investors investing into hedge funds, not just locally but globally. This amounts to perhaps up to between USD1-200bn, which is around 10% of the global hedge fund industry".

Nilsson describes Japan as one of the world's biggest hedge fund investor markets. "Most of this money is invested with big global names with long track records. While the major banks and insurance companies in Japan invest in hedge funds and have done for many years, the big growth area is pension funds. Corporate and industry pension funds have already gone in and now we are starting to see some of the big public pension funds looking at hedge funds too. High net worth individuals and other retail investors have been active hedge fund investors for many years but this investor segment has been impacted by poor performance and negative publicity around AIJ and Madoff, etc."

In terms of strategies, Nilsson finds that all do well but the more liquid strategies, such as equity long/short, global macro and CTAs have been popular across the board. "But we have also seen investments into credit strategies, for example" he says.

The hedge fund industry in Japan was rocked last year with theAIJ scandal with managers and investors expressing concern about the long-term implications for the industry. Nilsson believes that the positive impact of the AIJ scandal has been that investors will be more likely to invest in established managers with established local partners promoting their products in Japan, and that fraudsters or fund managers without a proper institutional set-up will now find it increasingly difficult to attract Japanese investments.

This is good news for the Japanese hedge fund industry, Nilsson believes, and observes that the big growth area is investments from pension funds. "While many financial institutions are not making big increases they often keep their existing levels of hedge fund investments steady. Within those portfolios there are plenty of opportunities to win mandates as there is always a certain degree of manager turnover each year. Many of the big banks and insurers in Japan already have multi-billion dollar hedge fund portfolios" Nilsson says.

Hedge-fund clients of Bank of America Corp’s Asian prime brokerage unit have increased their leverage since October as the market outlook improved, according to the second-largest U.S. bank by assets.

Gross leverage, which tracks hedge funds’ long and short positions as a multiple of the cash they get after selling all securities and repaying borrowings, have increased since late October through Jan. 17, said Ben Williams, Hong Kong-based head of Asia-Pacific financing sales in the bank’s Merrill Lynch unit. Shorting involves selling borrowed securities in anticipation of buying them back for a profit when their prices fall.

“This move has been more significant than other years,” Williams said in an interview yesterday. “There’s opportunity to do more things in Asia, whether long or short.”

Companies in the Asia-Pacific region and their shareholders sold more than USD57 billion worth of shares and convertible bonds in the last four months, almost twice the amount in the fourth quarter of 2011, according to data compiled by Bloomberg.

“There’s been a general uptick in turnover across Asia, being led by Hong Kong and China,” Williams said. “High volumes and more mass participation have created deal flows and chief financial officers and chief executive officers are looking at opportunities to sell stock and pay down debt.”

Asia-focused hedge funds returnedabout 10 per cent in 2012, with 8 per cent of the gains coming in the second half, according to Singapore-based data provider Eurekahedge Pte.